This week we heard from the UK Prime Minister that he plans £3 billion of government asset sales, and a further £13 billion of local government asset sales, to help with the UK's budget deficit problems. It served to remind markets of the magnitude of the task. The £3 billion from central government assets will only meet the Treasury's needs for six days, then it is back to borrowing again. The £13 billion requires the willingness and drive of many Councils to see it through.
Meanwhile the big numbers remain the Bank of England's quantitative easing programme and the borrowing requirement, both currently at £175 billion. The Bank will have to decide next month whether to ask the Chancellor for permission to increase the QE programme again. They will be tempted to do so, as the government is keen to engender more feel good before the election, and the Bank remains preoccupied by the threat of deflation. There is a danger of the borrowing growing of its own accord. There is little sign yet of austerity breaking out in Whitehall or Town Hall. The Prime Minister remains wedded to the notion that any premature reduction of spending would be bad for the recovery. His Finance Minister is not so sure, showing concerns for the size of the deficit and its affordability.
So far the strategy of requiring the main banks to lend more to the government in the interests of increasing their holdings of liquid government bonds, allied to the substantial Bank purchases of second hand gilts, has allowed the deficit to be financed easily without official interest rates rising. Some strain has been felt on the currency, which has been falling again this month against most other currencies. The Bank is preoccupied by the recession, and seems quite relaxed about the inflationary consequences of the lower pound, and higher taxes, commencing with the 2.5% increase in VAT at the year end.
The presence of so much easy money and low interest rates worldwide continues to drive most asset prices higher. Share prices and commodity prices are well ahead of real recovery in the underlying economies. The fall in the dollar and the pound should have some favourable impact on the large balance of payments deficits of those two countries. It also means tougher conditions in export markets for the leading export economies. The end of ‘cash for clunkers’ schemes in the US and Germany will dampen the reviving car markets.
We are remaining fairly fully invested, but are giving more emphasis to higher yielding high grade corporate debt and less to now low-yielding equities, given the pace of the rise so far this year. The tide of easy money does raise most boats. It will also reveal some that were so holed they cannot float again. We think the risks in the UK, with the treble deficits of the private, banking and government deficits remain high. The banking crisis may be under control, but the West seems destined to live with impaired banks for some time to come. Many of the underlying problems in their asset portfolios remain to be sorted out. The combination of easy money and state guarantees is no substitute for banks working their way through their complete asset portfolio and establishing a firm base of performing loans from which to make a profit.